Mr Holding, who has been a member of Parliament since 1999, says he does not have another job to go to and concedes a by-election will cause inconvenience.

He has ruled out a future return to politics and has denied factional splits led to his resignation.

Mr Holding says he has been in politics from a very young age and it is time to consider new directions.

"I'm not the sort of person who could have sat on the backbench for a couple of years, waiting to retire," he said.

"That is not the sort of person that I am, waiting to retire."

Mr Holding was the minister for water when the former Labor government awarded the contract for the controversial Wonthaggi desalination plant and served in the governments of Steve Bracks and John Brumby.

Holding made headlines in 2009 when he got lost while bushwalking on Mount Feathertop.

He spent two nights in the bush before being rescued.

Liberal powerbroker Michael Kroger says he was shocked to hear about Holding's resignation.

"I was assuming he would end up leader of the party in the next couple of months," he told ABC local radio.

"Look [Labor leader] Daniel [Andrews] is not really up to the job.

"That's why I thought Tim Holding would take over. I presume therefore Jacinta Allen will take over before the next election."

Bronwyn Pike, a former labor education minister who worked with Mr Holding, says he is a highly-intelligent contributor to the party.

"I think there comes a time for some people, when they feel that they've made a long and substantial contribution and it's important to allow other people to step up and take leadership positions," she said.

"What goes on within the party, who are of course the people who choose the leaders, is not always what people from the outside observe."

It is unclear when Mr Holding plans to leave Parliament, but with a state election not due until November 2014, a by-election in his seat of Lyndhurst is likely.